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Friday, Jul 09, 2004

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Personal finance: Thrust to direct equity investing

Suresh Krishnamurthy

IN 2003-04 Budget, the then Finance Minister cut the interest on small savings and reduced the tax on dividends and long-term capital gains. The cumulative impact of these measures was to give a thrust to equity investing vis--vis debt investing. This time around, the Finance Minister has further reduced taxes on capital gains. Despite this cut, there is no discernible tilt in favour of increasing allocation to equities. This is because the administered rates on small-savings schemes have not been changed.

That administered rates have been left unchanged has ensured that large surpluses running into lakhs can be parked in small savings instruments. In terms of risk-adjusted returns, small-savings schemes continue to reign supreme. Investors seeking monthly income can continue to rely on post office monthly income scheme. Post-office monthly income, when combined with post-office recurring deposit, yields about 9.3 per cent before tax. Investors seeking tax saving could opt for National Savings Certificate and Public Provident Fund. PPF yields about 10.2 per cent after tax. NSC yields, after tax, between 9.6 per cent and 13.9 per cent depending on the tax slab of the investor. As for other debt instruments, the threat of a rise in interest rates also favour higher allocation to small savings instruments now.

Fillip has been given to direct equity investing too. Reduction in short-term capital gains reduces the tax advantage enjoyed by mutual funds. If you hold a mutual fund for less than 12 months, you pay a tax of 30 per cent on the gains. If you hold a stock for less than 12 months, you pay a tax of 10 per cent on the gains. This problem is, however, mitigated to a large-extent if the fund declares dividend.

In addition, while long-term capital gains from investments in mutual funds is subject to tax at the rate of ten per cent, such gains for direct investing is totally exempt from tax.

In the sphere of insurance, term assurance just became costlier with the imposition of the ten percent service tax. The proposal is, however, broadly welcome since in the case of all plans, insurance companies will now be forced to indicate the proportion of term assurance in the premia paid for all policies. This remained an unknown component for investors until now. The insurance industry may just be forced to revamp the structure of all savings-oriented plans. If this also brings down the administrative charges in the case of unit linked plans, then it would be even more beneficial to investors.

According to Mr S. B. Mathur, Chairman, LIC, "The service tax issue needs some more clarity. Earlier, most companies were absorbing the service tax while some were passing it on to the agents. Now that they have extended the tax to risk premium, it might be difficult to implement it from the administrative point of view. For example, people in the higher age group will pay a higher risk premium and the ones in the lower age bracket pay a lower risk premium. Once again, it is the senior citizens that will be affected. The same proposal came up a couple of years back and with some deliberations with the government they took our concerns into consideration and it was stalled."

As things stand, it would be better if investors now take judicious recourse to small-savings and direct investing in stock markets. These relative advantages may not last beyond February 2005, when the next budget is presented.

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